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I-T invites comments on draft rules for valuing startup investment by non-residents

This move was considered after Industry bodies of startups and venture capital investors suggested a raft of measures to the Central government so that its move to include investments from foreign investors under the ambit of angel tax doesn’t hurt start-up funding.

May 27, 2023 / 04:36 PM IST
The rules would be effective from April 1, 2023.

The rules would be effective from April 1, 2023.

Just a day after notifying 21 countries that non-resident Indian investment in unlisted startups will not attract angel tax, the income tax department on Friday invited comments from stakeholders on rules for valuation methods for such fundings.

Read | CBDT notifies 21 nations from where investment in startups will be exempt from angel tax

The Central Board of Direct Taxes (CBDT) has, in a draft notification, invited comments on the draft rule 11UA of Income-tax Rules, 1962 on the computation of Fair Market Value (FMV) of unquoted equity shares through five methods under Section 56(2)(VIIb) of Income-tax Act, 1961.

Rule 11UA, which is now in practice, prescribes two valuation methods - Discounted Cash Flow (DCF) and Net Asset Value (NAV) - for resident investors.

The government intends to include five additional valuation methods specifically for non-resident investors, in addition to the existing DCF and NAV methods.

"The new valuation methodologies released by CBDT offers significant clarity on angel tax. These methods are internationally accepted and form the basis of valuation of companies with traction and an operating history. The big question that still remains is how deviations of performance vs projections will be handled by the department," said Siddarth Pai, managing partner at venture capital firm 3One4Capital.

"The industry would welcome clarity on how the tax officers will view such changes. An SOP would add clarity and ensure that legitimate capital is not prejudiced due to normal business changes," he added.

The draft rules provide startup investors 10 percent variation from the determined value. This gives room for concessions for forex fluctuations, bidding processes, and variations in other economic indicators.

In case a company receives any consideration for issuing of shares to a non-resident entity, the price of the equity shares may be taken as the fair market value. This will be if the consideration from such FMV does not exceed the aggregate consideration that is received from the notified entity within a period of 90 days from the date of issue of shares which are the subject matter of valuation.

"The 10% safe harbour in valuation, the concept of price matching and the proposed five new methods of valuation are all very welcome. Though all newly proposed five valuation methodologies for arriving at fair market value (FMV) of unquoted shares to be issued to non-resident investors, as such need to be determined by Category I Merchant Banker registered with SEBI only, who were earlier also authorised to issue valuation report under DCF method as well," Salman Waris, managing partner at technology-focussed law firm TechLegis.

On similar lines, price matching for resident and non-resident investors would be available with reference to investment by venture capital funds or specified funds.

The same 90-day cap is proposed for the valuation report by a merchant banker for the purpose of this rule.

Stakeholders and the general public can send suggestions and comments on the draft rules by June 5 to, the CBDT tweeted.

Bhavin Shah, Deals Leader at PwC India, said “Almost all fresh investments by VC Funds in start ups has historically been through compulsorily convertible preference shares. The relaxation provided under draft rules for price matching and 10% safe harbour is restricted to equity shares. It is important that these relaxations are extended to investments by way of CCPS as well.”

Also Read | Startup investors breathe a sigh of relief as government proposes tweaks in angel tax

On May 20, Moneycontrol had reported that the finance ministry’s proposals to exclude certain parties, like pension funds and sovereign wealth funds, from the ambit of the angel tax.

This move was considered after Industry bodies of startups and venture capital investors suggested a raft of measures to the central government so that its move to include investments from foreign investors under the ambit of angel tax doesn’t hurt start-up funding.

Under the existing norms, only investments by domestic investors or residents in closely held companies were taxed over and above the fair market value, which was referred to as angel tax.

A few experts highlighted that while these changes don't have any implications on AIFs, but because it impacts non-residents, it also ends up impacting startups in general. That was primarily because a large number of companies raise rounds from angels and others who are non-residents, therefore any implication on the non-residents would have an influence on the ecosystem at large.

Karthik Reddy, co-founder, Blume Ventures and chairperson, IVCA, also pointed out that, "Secondary transactions are generally at a discount to the primary infusion and these are generally constructed together. With this change, a company will always end up paying tax on the primary price to the extent it exceeds the secondary price/valuation report. This would lead to exits/ liquidity not being preferred/rounds not getting constructed."

Pallav Pradyumn Narang, Partner, CNK said, "he introduction of these new methods will provide additional pricing options to the investors. It may be noted that the previously allowed methods, namely NAV and DCF as certified by a merchant banker have not been tinkered with. The valuation rules have gained greater significance in recent times on account of the withdrawal of exemptions granted to non-resident investors under section 56(2)(viib). Given that the difference between the fair market value and the investment value of these shares will be subjected to tax in India. it is important from an investor as well as investee perspective to have the FMV dialled down in line with the investment values. The addition of the new methods will allow the investors and investees to be able to map FMV against investment values and reduce tax impacts, if any."

S. Vasudevan, Executive Partner, Lakshmikumaran & Sridharan attorneys said. "The recent changes proposed by the CBDT to income tax rules prescribing the manner of arriving at the fair market value (FMV) is likely to bring much-needed relief to the start-up ecosystem in India. The draft rules give an option to the start-ups and non-resident investors to choose from a range of valuation methods to arrive at FMV."

The angel tax regime had originally started in 2012 as an anti-abuse measure to prevent money laundering. It mandated that a startup’s fundraising could be taxed whenever the funding round happened at a valuation above the fair value of shares – as determined by a merchant banker.

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Moneycontrol News
first published: May 27, 2023 07:50 am